Fixing A Low Margin Business | 314

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Transcript

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Welcome back to the Business Readers podcast. Today in all this week, I am going through a number of the topics that we discussed at my hot seat event last week in Philadelphia. I'm hosting the next one in September. If you want to get on the wait list for that, there's a link at the bottom that says send me a text. Just shoot me a text, your name, your phone number. I will send you back a sign-up form so you can get on the wait list. So as soon as we release tickets, you could be invited. There's only going to be so many seats. I'm not exactly sure yet, but probably maybe 20, 25, something in that range. And so get a list if you want. If you don't make it to this one, I'll get you maybe on the next one. So one of the problems that one of the members had was low cash flow. So he was doing about $2 million in revenue and $20,000 in profit. So a 1% uh like net margin. Now we had no debt because he paid everything in cash and ran the business. And he built it up like this was like two years in. So like really fast growth, uh, which is which is awesome. And but cash flow is tight, and cash flow, the margins just aren't where they need to be. So the question is, well, how do I fix it? Like, I've got this problem, I'm not making enough money, I've got the revenue, I've got the leads, but like where like where's all the money going? And so I'm gonna walk you through the process that we applied uh to him. And if if you're feeling something similar, if you want to apply these numbers to your business, this is like a pretty simple exercise. So the first thing that I'm gonna look at is at the top, we're gonna look at your cost of goods. So in in most of these businesses, it's like you know, sales minus your your cost of goods. And in his and mine, you know, cost of goods I define as just the materials. So uh it was a service-based business, and they sold some parts too. And so uh we looked at like the parts that went in to deliver the service. And his margin was industry standard. Like it's it's a lower margin business. I want to say he was about a 45% uh gross profit, which in his business is pretty pretty normal. So uh there are some opportunities for him to increase that to maybe 50%, but he's in the ballpark, right? It's not like he should be out, he should be at 60 and he's at 45. There is probably about five points that he could potentially pick up through adding new services that some of his competitors do. So that is the first place I would look is what is your gross margin? How does it compare to standard? If it's too low, the only ways you can increase it are one, you try to buy parts cheaper, which in his case, like it's a commodity, can't really do that. You can increase your price, but if you price it too high, then you know you're not gonna you're gonna miss sales and you're gonna get a reputation that way. Or the third option, which was like, is there a new service that we can add that is higher margin? So a new higher margin business can drive more volume, and there you go, cost of goods is in fixed. Then we got into his some of his other costs. How much was he spending on uh ads? It was a little high, but he he was driving a tons of lease, so it was it was somewhat effective. We looked into some of his fixed costs, his rent wasn't that bad, like all of his other stuff. And then we got into payroll. Now, payroll is where most people lose all of their margin. And it's tough because payroll in a lot of times is a uh is an investment, right? Like you invest in high quality people, you will get a return. But on the other hand, if you invest in people and you don't get a return, then it feels like a huge expense and a huge waste. And so uh here's some of the numbers, here's some of the ways that we looked at it. So he was doing about $75,000 a month in gross profit. Okay, so that's key. $75,000 a month in gross profit. His payroll was about $40,000 a month. And one of the metrics that I try to run by is I want um the if take the gross profit dollars, so $75,000, divide it by the payroll, and you want to get about three, right? It said another way, you want your gross profit to be roughly three times your payroll. So uh gross profit, $75,000 divided by $40,000 got us to about a 1.8, all right. So 1.8, 1.87. Some months you did 80,000 divided by 40, you could say that's a two. So somewhere between 1.8 to 2. Okay, the goal is three. At 1.8, there's just not enough margin, right? Because that means, you know, huge amount of of your gross profit is is eaten up by payroll, you still gotta pay rent, you still got ads, you still gotta make money, you've got insurance, you got all these other costs. But if um, but if if that amount is taken up, you're you just don't you just don't have enough. So, um, so for example, if his gross profit was $75,000, divide that by three, this is the other way you do it, you would get your target payroll. So 75 divided by three is 25. So one way to look about this is based on his current volume, his payroll budget should be 25,000. He's currently spending 40,000, right? So we got $15,000 of you know, inefficient, highly inefficient payroll, ineffective payroll. Now, he's a lot of money, right? Like he has pretty good headcount too. So he's like, this is like cutting multiple people to make this happen, potentially. Uh the other way to think about it is the reverse to say, well, my team is awesome. I don't want to cut my team. So it's okay. Then you take your payroll of $40,000 and you multiply that by three, and you'd get $120. So he has two options. If he's maintained, if he thinks, hey, the business is kind of maintaining this is like a steady state, then like he he needs to figure out his payroll issue. He needs he's either overstaffed, he's underpriced, but we don't think he's underpriced because of the the cost of goods thing. Um, or he has to get like more out of the people he's got. Maybe he has the right number of people, they're just not as efficient as they need to be. Um because he needs to either generate $120,000 of gross profit, or he needs to cut his payroll by $15,000. Like those are literally the two options. Now, there's obviously a third, which is like maybe payroll gets cut a little bit, and then the multiple that he needs isn't as much, but um, you know, it the approach is gonna be pretty much the same. And, you know, the toughest part is that the payroll is an investment, and that if you feel that you're constantly cutting payroll and watching hours and like you you approach it with a scarcity mindset, then like you know, you you're you're probably not gonna grow and you're not gonna hit the results. But on the other hand, like him, like his challenge is like all of his cash flow is getting eaten up by payroll, and there's just just not enough then to reinvest. And he has he has plans for growth. Like he he he sees himself having 10 locations or or more, which is awesome. Any any any any I believe in him. I really think he can do it. But all that is on the side right now. Like, there should be no attention put to any sort of growth or next steps or like future until we fix the margins. Because the cash flow is the lifeblood of the business. These are cash flow businesses. They aren't they aren't building big equity. There's gonna be no big like payday, like getting 10 or 10, 10 or 20 or 30 times or whatever, like a tech company would, right? Like, yes, you may be able to resell the business, you know, one day and you build equity that way, but maybe not. You know, that you you never know. Like, and the the main thing is these businesses need to be cash flow machines. They you need to be pulling distributions every single month. And then with those distributions, yes, you can go and invest and open up new stores and acquire competitors, you can buy the real estate that you own, that you can build some equity in, you can put it in the stock market, right? You can you can use the cash to grow the business, but if you don't have the cash, you have nothing to grow the business with. Like the cash is the lifeblood. And I I I talk to so many people, and they they're they're just so focused on sometimes a couple steps down the line that they forget that the most and thing, the most important thing that matters today is getting the margins good. Now, in his business, he should probably be about a 10 to 12 percent net. So he's leaving, you know, $200,000 or more on the table that is literally at his fingertips if we can fix a few things, which could be some margin, which could be some payroll. And so that's like his homework was to go back, was to really focus on uh the the specific team, each member, and really get back get back in there, get his hands dirty, really figure out every single thing and how do we optimize it because uh he's got such a great opportunity, such a great business uh right now in such a short amount of time, but now we got to fix the margins, which honestly is sometimes an easier problem than have than like somebody who has like no leads and no revenue and they're like they're scrapping to get by. This is somewhat an easier problem. So I I know honestly, within a couple weeks he could have this solved. So try this exercise. Gross profit divided by your payroll, your goal is three. So 75,000, if you're if you're at divided by 25,000, that's your target three. Said reverse, you take your payroll dollars currently, you multiply by that three, and then that's the goal for gross profit. And then you can play around with with those numbers and see where you're at. Uh, and that's all I got for today. Um, try it out. It works really well. At least it works in my business. It's worked in a couple others that we played around with. And uh I would love to hear your numbers. You can shoot me a message on on on uh on Twitter or X on Instagram uh or here, and I'll see you in the next one. Cheers.